Section 174 R&D Expensing Changes: What Manufacturers Must Know

If your engineers spend time improving a process, building a prototype or developing custom tooling, the tax treatment of that work changed in 2025. For three years you had to spread domestic R&D costs over five years. Now you can deduct them again in the year you pay them.

This matters more in manufacturing than almost anywhere else. According to the National Science Foundation, companies in manufacturing industries performed $394 billion, or 55%, of domestic business R&D in 2023 (NSF NCSES, 2025). That figure is driven by large companies, but the same rules apply to a 40-person machine shop.

Below is where things stand in late 2026: what changed, what the July 2026 deadline was and what it means that it has passed, and what to do on this year's return.

This is general information, not tax advice. Work with your CPA on your own facts before you file.

What Was Section 174, and Why Did It Hurt Manufacturers?

Before 2022, Section 174 was simple. If you spent money on qualifying research and experimentation, you could deduct it that year.

The 2017 Tax Cuts and Jobs Act changed that for tax years beginning after December 31, 2021. Domestic R&D costs had to be capitalized and amortized over five years. Foreign research went to 15 years. A mid-year convention meant you only got half a year of amortization in year one.

Here's an illustrative example. Say your engineering team spent $500,000 improving a production process in 2022. Before the change you'd deduct all $500,000 that year. Under the TCJA rule you deducted $50,000 in year one, which is $500,000 over five years, halved for the first year. The other $450,000 came over the next four and a half years.

That's not just an accounting detail. It meant higher taxable income, higher estimated payments and less cash in the business, and it hit companies doing exactly the kind of work we want them doing.

What the One Big Beautiful Bill Act Changed

The tax law signed July 4, 2025 (P.L. 119-21, usually called the One Big Beautiful Bill Act or OBBBA) added a new code section, Section 174A.

For tax years beginning after December 31, 2024, domestic research and experimental expenditures are deductible in the year paid or incurred. The five-year amortization is gone for research done in the U.S.

There's one carve-out. Research done outside the United States still has to be capitalized and amortized over 15 years. If you use an engineering firm overseas, or your parent company does development work abroad, those costs stay on the slow schedule.

You also have a choice. Section 174A(c) lets you elect to capitalize domestic R&E and amortize it over a period you choose, of at least 60 months. Why would anyone do that? If you're in a loss year or expect higher income later, spreading the deduction may be worth more. I don't think it's the right answer for most profitable shops, but it's worth asking.

What Qualifies as R&D in Manufacturing?

Many owners assume R&D means a lab. It doesn't. Section 174 covers costs of developing or improving a product or process where you're uncertain about the capability, the method or the right design at the start.

For a manufacturer, costs that may qualify include:

• Process improvement engineering: engineer and technician time spent improving yield, cycle time or quality when the answer wasn't known going in.
• New product development: design, prototyping, testing and iteration.
• Software development: the law treats software development costs as R&E, including code written to run equipment or manage production.
• Test materials: raw materials and parts used up in trials and first-article runs.
• Tooling and fixture development: developing custom tooling for a new process, where there's real technical uncertainty.

Routine production, quality control testing and ordinary troubleshooting don't qualify. Neither does the cost of the equipment itself, which goes through depreciation instead.

The practical issue is tracking. If your chart of accounts and timekeeping don't separate R&D labor and materials from production costs, you'll be estimating at year-end, and estimates are hard to defend. Our post on the financial management control process covers how to set that up.

The retroactive relief for small businesses: what happened

The 2025 law also gave smaller companies a way to go back and fix 2022 through 2024. If your average annual gross receipts were $31 million or less under the Section 448(c) test, you could elect to apply Section 174A to those years, generally by amending all of the affected returns together.

The IRS set the procedures in Rev. Proc. 2025-28. The election had to be made by the earlier of July 6, 2026, or the normal refund deadline for that year. That deadline has passed.

If you made the election, a few things are worth checking now:

• Did the state returns get amended too, if your states follow the federal treatment?
• Was the research credit handled consistently on the amended returns? The amended years also had to apply the new rule that reduces the R&E deduction by the credit.
• Are the refunds recorded correctly on your books, with any related deferred tax balances cleaned up?

If you didn't make it, you didn't necessarily lose the deduction. Your unamortized 2022 to 2024 costs could still be recovered on your 2025 return under the general transition rule in the next section. You just can't get the money back for the earlier years through that election anymore. If you think you missed something, ask your CPA whether any other option applies to your facts. I'm not aware of a general one.

What about the 2022 to 2024 costs you were amortizing?

Every company, large or small, could choose what to do with domestic R&D costs still sitting unamortized from 2022 through 2024. Under Rev. Proc. 2025-28 the options were to deduct the whole remaining balance on the 2025 return, or spread it evenly over 2025 and 2026. Companies that made neither choice could keep amortizing on the old schedule.

For a calendar-year company, that choice was made on the 2025 return, which most have now filed. So the question for 2026 is mostly about follow-through.

If you chose to spread it, half of the catch-up lands on your 2026 return. That's a deduction you need in your 2026 projection and your estimated tax payments. If you have a fiscal year, the timing may be different, so check with your CPA.

The trade-off was always about income. Deductions are worth more in a high-income year. A C corporation's net operating loss can generally only offset 80% of taxable income in a later year, so creating a big loss with a catch-up deduction isn't always the best use of it. This is where your tax plan and your cash flow forecast need to talk to each other.

The R&D Tax Credit Is Still Worth Claiming

One mistake to avoid: assuming that because the deduction is back, the Section 41 research credit doesn't matter. They're two separate benefits.

The deduction lowers taxable income. The credit lowers the tax itself, dollar for dollar. At a 21% corporate rate, a $100,000 deduction saves about $21,000. A $100,000 credit saves $100,000.

They interact. For tax years beginning after 2024, Section 280C generally requires you to reduce your Section 174A deduction by the amount of the credit. The other option is to elect a reduced credit and keep the full deduction. Your CPA can model which leaves you better off. In most cases I'd expect claiming both to beat the deduction alone, but run the numbers.

The IRS has also asked for more project-level detail on Form 6765 in recent years. You need to show which people worked on which projects, how much time, and what technical question each project was trying to answer. Build that tracking into the year, not into March. Our post on the R&D tax credit for manufacturers covers the credit in more detail.

A worked example for 2026

Here's an illustrative case, not a client. A C corporation spends $400,000 on domestic engineering wages and test materials in 2026 that qualify as R&E. Assume a 21% federal rate and enough income to use every deduction.

Treatment	2026 deduction	2026 credit	2026 federal tax saved
Old TCJA rule (five years, half in year one)	$40,000	$0	$8,400
Section 174A deduction only	$400,000	$0	$84,000
Section 174A plus a $30,000 research credit, deduction reduced by the credit	$370,000	$30,000	$107,700

The math: $370,000 times 21% is $77,700, plus the $30,000 credit, is $107,700. The credit amount here is made up to show the interaction. Your actual credit depends on your qualified costs and the method your CPA uses.

The cash point is the gap between the first and second rows. Under the old rule, this company would have paid about $75,600 more in tax in 2026 and recovered it slowly over the next five years.

How This Affects Your Financial Statements and Cash Flow Planning

Under GAAP, R&D costs are generally expensed as incurred, so your P&L didn't change when the tax rule did. What changed was the tax return. The difference between book and tax created deferred tax assets on GAAP financial statements while costs were being amortized for tax.

Those balances unwind as you deduct the remaining costs. If your financial statements include deferred taxes, make sure they reflect what was actually done on the 2025 return. That matters if you're refinancing, talking to a buyer or reporting to a bank.

On the cash side, deducting R&D in the year you spend it means lower taxable income and lower estimated payments. If you've been squeezing working capital to cover quarterly taxes, this helps. But only if the estimates are updated. Overpaying all year and getting it back the following year is a loan to the IRS at zero interest.

What to do on your 2026 return

Here's the list I'd work through before year-end:

1. Confirm what was elected on the 2025 return: full catch-up, two-year spread, or continued amortization.
2. If you spread it, put the 2026 half into your projection and your fourth-quarter estimate.
3. Separate domestic and foreign research costs. Only domestic costs are deducted currently.
4. Decide with your CPA whether to deduct domestic R&E or elect to amortize it over 60 months or more.
5. Pull together time records and project notes for both the deduction and the credit.
6. Check state conformity. Not every state follows the federal rule, so state taxable income may differ.

R&D is one piece of year-end. Equipment, inventory and bonuses are the others, and we cover them in our year-end tax planning guide for manufacturers. If you're also buying equipment, see Section 179 vs. bonus depreciation.

How Accounovation helps manufacturers with the Section 174 changes

We're not your tax preparer. We're the finance team that sets up the cost codes, keeps engineering time and materials tracked, and hands your CPA clean support at year-end. Here's how we work with your CPA.

We also put the tax effect into your budget and cash forecast, so estimated payments match what you'll actually owe. It's part of our manufacturing tax strategy work and our budgeting and forecasting service.

If you want help tracking R&D costs this year, that's part of our fractional CFO work. Happy to jump on a call if helpful.

Frequently Asked Questions

Can manufacturers deduct R&D costs in 2026?

Yes, domestic research and experimental costs are deductible in the year paid or incurred under Section 174A. Costs for research done outside the U.S. still have to be amortized over 15 years.

Can I still amend 2022 to 2024 returns for Section 174?

Not through the small business election. That election had to be made by the earlier of July 6, 2026, or the refund deadline, and that date has passed.

What happens to R&D costs I was still amortizing from 2022 to 2024?

You could deduct the remaining balance on your 2025 return, spread it over 2025 and 2026, or keep amortizing. If you spread it, the second half belongs on your 2026 return.

Do I still need the R&D tax credit if I can deduct the costs?

Yes. The credit reduces tax dollar for dollar; you generally reduce the deduction by the credit, but claiming both is usually worth more than the deduction alone.

How do I start tracking R&D costs properly?

Set up separate cost codes for R&D projects. Then track engineer and technician time by project, record test materials separately, and write down the technical question each project is trying to answer.